16 T.C. 820">*821 Respondent has determined a deficiency of $ 104,579.80 in the income tax of petitioner for the taxable year ended December 31, 1943. The deficiency results from the respondent's addition of the sum of $ 138,611.05 to the petitioner's 1942 ¹ income, which amount respondent has determined as the fair market value of 2,177 shares of Lanteen Realty Company common stock and the gain on the $ 50 in cash received in 1942 by petitioner from Lanteen Laboratories, Inc., in exchange for certain shares of the latter's capital stock.

The principal issue is whether the gain realized by petitioner on the exchange was postponed under the provisions of section 1951 U.S. Tax Ct. LEXIS 222">*225 112 (b) (3), or whether such gain was taxable as ordinary income in 1942 under the provisions of sections 22 (a), 115 (a), and 115 (g) or 112 (c) of the Internal Revenue Code. In the event it is held herein that the petitioner's gain was not postponed, then a further issue arises as to the fair market value of the 2,177 shares of stock received by petitioner.

FINDINGS OF FACT.

Rufus Riddlesbarger, the petitioner, is an individual with his principal office at 900 North Franklin Street, Chicago, Illinois. Petitioner's income tax return for the taxable year 1943 was filed with the collector of internal revenue for the first district of Illinois.

Lanteen Laboratories, Inc., hereinafter referred to as the "parent," was organized in 1928 under the laws of Illinois. Lanteen Medical Laboratories, Inc., hereinafter referred to as the "subsidiary," was organized in 1934 under the laws of Delaware. Both companies maintain their principal offices in Chicago, Illinois.

Since its incorporation the subsidiary has engaged in the manufacture and sale of various pharmaceutical and biological products and apparatus. It has also engaged in continuous research to improve its present products and to1951 U.S. Tax Ct. LEXIS 222">*226 develop new products. The commercial manufacture and sale of hormone preparations were begun in the spring of 1946.

The subsidiary was organized in 1934 for the purpose of dividing operations along state lines. It merchandises its products in all states except Illinois. The parent since 1934 has done no manufacturing, but purchases its merchandise from the subsidiary, and conducts merchandising operations only within Illinois.

From the date of its organization in 1934 through 1942, the subsidiary had issued and outstanding 7,400 voting shares of common 16 T.C. 820">*822 stock and 200 shares of non-voting preferred stock. The parent acquired in 1934 and at all times thereafter owned the 7,400 shares of voting common stock of the subsidiary. Petitioner has owned at all times material to the issues herein in excess of 90 per cent of the capital stock of the parent.

Petitioner actively participated in the operations of the parent and subsidiary and was the dominant and controlling personality in their affairs. He was president of the parent, but was neither an officer nor director of the subsidiary and did not own directly any of its stock. He selected the officers and directors of both1951 U.S. Tax Ct. LEXIS 222">*227 companies, determined whether new products were to be manufactured, and selected the auditors and attorneys for the companies. Apart from petitioner, the directors of both companies were salaried employees who ordinarily followed the directions and instructions of petitioner in performing their duties.

In about 1936 the subsidiary began experiments and research in hormones with a view to manufacturing a hormone preparation embodying natural hormones. While estrogenic hormones are present to some extent in the urine of almost any animal, the urine of pregnant mares is the most practical source. At the beginning of its hormone research, the subsidiary was able to obtain raw material in experimental quantities from stockyards. However, the subsidiary knew of no one source able to supply the raw material in commercial quantities. Some of the subsidiary's competitors maintained their own farms, from which they derived the raw material.

In November 1937, the subsidiary purchased 2,400 acres of improved ranch property in Cochise County, Arizona, for 24,025, allocating $ 13,525 of the purchase price to the land and the rest to the improvements. Petitioner determined that the subsidiary1951 U.S. Tax Ct. LEXIS 222">*228 would acquire the ranch and conducted the negotiations leading to the purchase. On July 31, 1938, the subsidiary purchased an additional 160 acres in Cochise County for $ 675.

The ranch was located on the Bisbee-Nogales paved highway, Arizona No. 92, about 25 miles west of Bisbee, on the west slope of San Pedro Valley, at the foot of the Huachuca Mountains, and about four miles north of the Mexican border. Its elevation was approximately 5,000 feet above sea level.

Beginning about the middle of 1938 and prior to November 1942, the subsidiary began to make extensive improvements to the ranch property and to acquire equipment and livestock. By reason of these improvements and acquisitions, the investment of the subsidiary in the ranch increased, apart from any consideration of depreciation, from $ 24,025 in 1937 to $ 170,011.15 in 1942. By 1941 and 1942, the investment by the subsidiary in physical ranch assets inuring primarily 16 T.C. 820">*823 to petitioner's personal benefit was larger than its investment in physical ranch assets directly connected with its business.

The ranch was divisible into three units, hereinafter referred to as the main dwelling unit, the cattle ranch unit, and1951 U.S. Tax Ct. LEXIS 222">*229 the miscellaneous ranch property. The main dwelling area where petitioner resided with his family was located about one-half a mile north of the highway and was connected thereto by a paved drive. The main house was of antique Indian pueblo design and contained some 10 or more rooms, including three bedrooms, three baths, a powder room and a half bath for the kitchen. Approximately 100 feet from the main house was a guest house consisting of three main rooms, a bedroom, a large sitting room and bedroom with fireplace, a kiva used as a billiard and pingpong room with a fireplace, one large bathroom with both shower stall and tub, a combination half bath and dressing room, and a supplementary service trunk room. Adjoining the guest house was a garage which accommodated four cars and included a garden tool room and freezer room.

Service buildings located in the main dwelling unit included a lodge for the household staff, containing four bedrooms, living room, kitchen, laundry room and two baths; a tool room, storage house, three engine houses, calf barn and stock shed. All buildings except one engine house, the calf barn and stock shed were of antique Indian pueblo design.

Utilities1951 U.S. Tax Ct. LEXIS 222">*230 were supplied to the buildings in the main dwelling unit by electric, water, gas, telephone and sewer systems. Water was obtained from a natural spring and a driven well. Connecting sidewalks and roadways were installed. The grounds were extensively landscaped and supplied with water by a sprinkler system. Three reservoirs were available for the storage of water. One reservoir was located at the spring and two other cement-lined reservoirs, one 12,000 square feet by 16 feet deep, and another 1,600 square feet by 6 feet deep, were used for the storage of flood water for the irrigation of the yards.

On the grounds surrounding the main house was an 18-hole golf course consisting of five greens and about a dozen tees, which was completely piped for water.

The total original cost of the main dwelling unit, including the land and all improvements, was $ 90,440.29 and the cost, after giving effect to depreciation, was $ 80,925.02, as of November 1942.

The cattle ranch unit was situated on the south side of the highway and comprised approximately 2,500 acres of land on which were located a complete set of farm buildings, a hangar, and airport runways.

16 T.C. 820">*824 The farm buildings included1951 U.S. Tax Ct. LEXIS 222">*231 a foreman's house of adobe, rock, and frame construction with a floor area of 1,236 square feet, a garage, two stables, a feed shed, stock sheds, stock pens and three horse barns. In addition, there were 11 corrals and 17 miles of fences. The cattle ranch was equipped with a water system including a windmill, steel tower, well and pump, two storage tanks, seven water tanks, and a 3-mile pipeline.

Airport facilities consisted of a hangar, 46 feet x 52 feet, and three-way grass runways.

The total cost of the property constituting the cattle ranch unit was $ 48,854.65 and the cost of such property, after giving effect to depreciation, was $ 40,124.83, as of November 1942.

The total fair market value of the main dwelling unit and the cattle ranch unit as of November and December 1942 was $ 90,000.

The third unit, miscellaneous ranch property, as of November 1942 consisted of such items as 19 Arabian horses, 13 Palamino horses, 7 pinto horses, 4 dairy cows, furniture and fixtures, cash, accounts receivable, prepaid insurance, and various equipment. The original cost of these properties was 30,716.21 and their fair market value as of November 1942 was $ 26,109.53. The fair market value1951 U.S. Tax Ct. LEXIS 222">*232 of the Arizona ranch owned and operated by the subsidiary in November and December 1942 was $ 116,109.53.

One of the purposes for the acquisition and improvement of the ranch property was the development of a source of supply of the hormone raw material in commercial quantities.

In 1940, a chemist who had been doing hormone research for the subsidiary at its Chicago laboratories left its employ and took his notes with him. In 1941, the subsidiary employed another chemist, Dr. Chester C. Fowler, to conduct the research in that field. Dr. Fowler discovered that patents had been granted to others which created a difficult situation and hampered the development by the subsidiary of processes and methods for extracting and purifying hormones from urine. He was successful, however, in working out a process for producing a concentrate at the ranch which would make it unnecessary to ship large quantities of urine to Chicago. This procedure was set up early in 1942.

Some difficulty was experienced in obtaining competent veterinary help at the ranch. The principal obstacle to the hormone program, however, was encountered in the fall of 1941, when a synthetic product named Stilbestrol appeared1951 U.S. Tax Ct. LEXIS 222">*233 on the market. While not quite as satisfactory for all purposes as the natural product, Stilbestrol had a similar therapeutic effect and its cost of manufacture was much lower.

No commercial hormone product was ever developed as a result of the experiments conducted at the ranch.

16 T.C. 820">*825 The operations of the ranch resulted in a loss to the subsidiary for each of the years as follows:

The losses from ranch operations for 1939 and 1940 in the amounts set forth above were reflected in the Federal income tax returns of the subsidiary for those years. The Commissioner notified the subsidiary by a 30-day letter dated April 7, 1942, that he proposed to disallow the deductions of the operating losses from ranch operations for the years 1939 and 1940 and to make assessments pursuant to section 102 of the Internal Revenue Code in the amounts of $ 36,609.48 for the year 1939, and $ 43,454.07 for the year 1940 on the ground that the subsidiary was availed of for the purpose of preventing the imposition of surtax within the meaning of section 102.

The Commissioner's assertion of section 102 was based1951 U.S. Tax Ct. LEXIS 222">*234 upon his contention that the ranch was acquired and operated primarily for the personal benefit and accommodation of petitioner. The subsidiary contended that the ranch was acquired and operated for the purpose of supplying the raw material needed for research in hormones and eventually for the actual production of hormone preparations, and that it had accumulated earnings and profits to finance a growing business and to purchase or erect a plant suitable for its needs. The gross sales of the subsidiary were as follows:

On December 31, 1939, the subsidiary had a capital of $ 76,000 and accumulated earnings and profits of $ 343,058.19, and on December 31, 1940, it had capital in the same amount and had accumulated earnings and profits of $ 453,583.58. During the period from 1934 through December 31, 1940, the subsidiary paid no dividends on its common stock.

The tax controversy for the years 1939 and 1940 was settled administratively on June 3, 1942. By the terms of the settlement, the subsidiary 16 T.C. 820">*826 1951 U.S. Tax Ct. LEXIS 222">*235 agreed to the imposition in respect to 1939 and 1940 of one-half of the surtax computed as provided in section 102 and was allowed to deduct for those years 40 per cent of the operating losses incurred in the ranch operations.

Subsequent to 1943, and after the transactions in issue, the Commissioner examined the Federal income tax returns of the subsidiary for the years 1941 and 1942. No surtax under section 102 was proposed by him for those years. The Federal income tax returns of the parent for the years 1939, 1940, 1941, and 1942 were also examined and no surtax under section 102 was proposed by the Commissioner in respect to those years.

Upon the Commissioner's disallowance of the operating expenses incurred by the subsidiary in connection with ranch operations for 1941 and 1942, the issue was submitted to this Court in Lanteen Medical Laboratories, Inc., 10 T.C. 279, wherein it was determined that expenses of the ranch were deductible to the extent of $ 6,481.65 in 1941 and $ 31,722.76 in 1942. The balance of the expenses, that is, $ 7,800 for 1941 and $ 6,000 for 1942, were found to be nonbusiness expenditures inuring primarily to the benefit1951 U.S. Tax Ct. LEXIS 222">*236 of petitioner and, therefore, not deductible.

Beginning in June 1942 discussions were had among petitioner, Walter H. Eckert, attorney for the parent and subsidiary, and John D. Filson, accountant for the companies, concerning the segregation of the ranch from the other assets of the subsidiary. In a letter from petitioner to Filson, dated August 6, 1942, petitioner suggested a plan whereby the subsidiary would transfer the ranch to a newly organized company in exchange for its capital stock, which stock would subsequently be transferred to petitioner "on an approximate equal valuation basis" for Class B common stock he held in the parent. In a letter dated August 20, 1942, Filson cautioned petitioner that a tax would be incurred under this plan and suggested a different procedure. The plan suggested by Filson involved (1) the payment of a dividend by the subsidiary to the parent consisting of the ranch; (2) a reorganization of the parent entailing the incorporating of a new corporation, hereinafter referred to as Realty, to which the ranch would be transferred in exchange for its stock; and (3) the recapitalization of the parent and a reclassification of its capital stock and 1951 U.S. Tax Ct. LEXIS 222">*237 the distribution of the Realty stock and the new reclassified stock of the parent to the parent's shareholders in exchange for their old stock in the parent. In a letter dated September 1, 1942, petitioner replied expressing approval of the plan.

In a letter to petitioner dated October 26, 1942, Filson summarized matters relating to the organization of Realty and the disposition of the ranch "which were the subject of discussion on Friday, October 16 T.C. 820">*827 23, 1942, by you, Mr. Eckert and me," and pointed out that if the plan went no further than to have the parent receive and hold the ranch from the subsidiary in payment of a dividend there would be a danger of section 102 being asserted against the parent. Filson explained:

However, the amount of the dividend would not be excluded from the Section 102 net income subject to the surtax on corporations improperly accumulating surplus. Therefore, if the Internal Revenue Bureau should decide that the retention of this dividend by Lanteen Laboratories, Inc. [parent] was for the purpose of preventing the imposition of the surtax upon its shareholders the company would be subjected to the surtax imposed by Section 102.

Filson also1951 U.S. Tax Ct. LEXIS 222">*238 discussed his prior suggestion relative to the organization of Realty, the transfer of the ranch by the parent to Realty for stock, the reclassification of the parent's capital stock, and the exchange of the old stock for the new, and pointed out that this would be a recapitalization under section 112 (g) and the exchange would be a tax-free reorganization. As the exchange of stock did not involve the Realty stock, Filson explained that the retention of Realty stock by the parent might also result in the assertion of section 102 against the parent. Filson related in his letter:

There is the possibility that the Internal Revenue Bureau will maintain that there is no legitimate business need for the Illinois corporation [Parent] to retain an interest in the Arizona ranch properties, and that it will maintain that those properties should have been distributed by the Illinois corporation, [Parent] in turn, to its stockholders as a dividend. Should they take this position they will quite likely assert the penalty surtax against Lanteen Laboratories, Inc. [Parent].

The prior organization of the new building corporation [Realty] and the1951 U.S. Tax Ct. LEXIS 222">*239 acquisition by that new building corporation of a plant site will go far to justify the ownership by the Illinois corporation [Parent] of the stock of the new building corporation, and its retention of an amount of surplus equivalent to the investment in the building corporation. It is the effect of the transfer of the ranch property to the new building corporation which is difficult to evaluate because even now it cannot logically be said that the ownership and operation of a ranch forms a part of the ordinary business conducted by Lanteen Laboratories, Inc. [Parent]. I suggest, therefore, that this entire plan be carefully reexamined.

I suggest reconsideration of the suggestion made in my letter to you dated August 20, 1942, namely:

Lanteen Medical Laboratories, Inc., [Subsidiary] shall declare and pay a dividend on its common stock in kind, payable by transfer of the Arizona ranch property to Lanteen Laboratories, Inc., [Parent] its majority stockholder. Lanteen Laboratories, Inc., will then reorganize and recapitalize, by reclassifying its capital stocks and forming a new corporation [Realty] to which the ranch properties will be transferred solely in1951 U.S. Tax Ct. LEXIS 222">*240 exchange for stock or securities of the 16 T.C. 820">*828 new corporation. The reclassified capital stocks and the capital stock of the new corporation formed to hold title to the ranch properties will be distributed to the present stockholders of Lanteen Laboratories, Inc., in exchange for their present holdings of Lanteen stock. This recapitalization and reorganization and the consequent exchanges by the present stockholders of existing stock for new stock and stock of the new corporation, will constitute a "reorganization" within the meaning of Section 112 (g) of the Code and non-taxable exchanges under the provisions of Section 112 (b) of the Code.

The "alternative" plan set out above was substantially the procedure adopted.

On November 9, 1942, the subsidiary declared and paid a dividend, consisting of the ranch, to the parent. In its Federal income tax return for 1942, the parent reported the receipt of a dividend in kind from the subsidiary consisting of the Arizona ranch of the value of $ 147,159.38, and computed and paid tax accordingly. Thereafter, the Commissioner increased the value from $ 147,159.38 to $ 153,000 and the parent paid additional taxes based on such increase 1951 U.S. Tax Ct. LEXIS 222">*241 in value. On September 8, 1948, the parent filed timely claims for refund of income and declared value excess-profits tax for 1942 on the ground that the fair market value of the reported dividend in kind was substantially less than $ 147,159.38.

In a letter dated November 10, 1942, the parent authorized and directed the subsidiary to convey the ranch to Realty. The Secretary of State of the State of Illinois issued a certificate of incorporation to Realty dated November 17, 1942. Realty received the ranch on November 19, 1942, in full payment for 2,312 shares of its common stock subscribed to by the parent. Thereafter, the only additional shares of stock ever issued by Realty were three directors' qualifying shares for $ 150 cash.

Prior to November 1942 the authorized capitalization of the parent consisted of 200 shares of preferred stock with no par value, 10,000 shares of Class A common stock, par value $ 50 a share, and 50,000 shares of Class B common stock with no par value but with a stated value of $ 5 per share. The preferred stock was entitled to cumulative preferred dividends of $ 8 a share per annum, and upon dissolution of the corporation was to receive $ 100 per share1951 U.S. Tax Ct. LEXIS 222">*242 from the net assets of the parent, plus all accrued and unpaid dividends. The Class A common stock was entitled to dividends of $ 4 a share per annum after provision for the preferred stock dividends, and upon dissolution was to receive $ 50 per share from the net assets of the parent, plus all declared and unpaid dividends after provision for the $ 100 per share to which the preferred stock was entitled. The Class B common stock was entitled to dividends of $ 4 a share per annum after provision for the preferred stock dividends and the Class A common stock dividends, and upon dissolution was to receive all remaining net assets of the parent after provision for the $ 100 per share to which 16 T.C. 820">*829 the preferred stock was entitled and for the $ 50 per share to which the Class A common stock was entitled. Both classes of common stock and the preferred stock were entitled to vote. In December 1942 there was issued and outstanding 751 ² shares of Class A common stock, 23,137 2 shares of Class B common stock, and none of the preferred stock.

1951 U.S. Tax Ct. LEXIS 222">*243 The corporate minutes of a special meeting of the board of directors of the parent on November 24, 1942, state that the president:

* * * called attention to the fact that the company had been organized a number of years ago and that it has, since its organization, engaged in the manufacture and distribution of additional products from time to time, and that in the future it may be necessary to procure additional funds with which to push the manufacture and sale of additional products and that he felt it would be advisable before that time approached that the corporation be reorganized so as to be in a better position to meet its future requirements.

The minutes further state that the board of directors resolved to accept the petitioner's plan of reorganization and submit it to the stockholders for ratification. The board further resolved to increase the capitalization of the parent from 200 shares preferred stock, no par value; 10,000 shares Class A common stock, $ 50 par value; and 50,000 shares Class B common stock, no par value, with a stated value of $ 5 a share to 1,000 shares preferred stock, $ 50 par value; 10,000 shares Class A common stock, $ 50 par value, and 50,0001951 U.S. Tax Ct. LEXIS 222">*244 shares Class B common stock, no par value, but with a stated value of $ 5 a share.

Petitioner's plan of reorganization, which was accepted by the board of directors, provided that upon recapitalization of the parent as aforesaid each owner of one share of the old Class A common stock would receive at his election either one share of the new preferred stock or one share of the new Class A common stock, and each owner of ten shares of the old Class B common stock would receive one share of new Class A common stock, nine shares of new Class B common stock and one share of Realty common stock.

The plan further provided that no certificate would be issued for shares of old B common stock, except in blocks of 10, and owners of odd shares of old Class B common stock might elect to exchange such stock for new Class A common stock share for share or receive cash at the rate of $ 50 per share.

Another provision of the plan was that owners of the first 5,000 shares of new Class B common stock who applied before January 1, 1945, would have the right to convert their new Class B common stock share for share for new Class A common stock.

The officers of the parent mailed to each shareholder of 1951 U.S. Tax Ct. LEXIS 222">*245 the parent company a formal notice of a special shareholders' meeting on December 16 T.C. 820">*830 7, 1942, together with a covering letter dated November 27, 1942, signed by petitioner, which stated:

Briefly, the re-organization of this corporation is for the purpose of creating a realty company. This company anticipates the acquisition of a suitable building site for construction of a factory and office building more suitable to the use of this corporation than our present rented quarters, after the conclusion of the present war and the building restrictions now existing.

It also separates from our drug trade operations the Arizona Ranch properties which were acquired for the purpose of developing the manufacture of hormone materials and the operations of which have proven unprofitable.

This re-organization also permits the transformation of your holdings of our Class B Common into a dividend paying stock, or cash as you may prefer.

A special meeting of the shareholders of the parent was held on December 7, 1942. The corporate minutes state that:

Thereupon, the matter of the reorganization of the company in accordance with the plan heretofore submitted to and adopted at a special meeting1951 U.S. Tax Ct. LEXIS 222">*246 of the Board of Directors held on November 24, 1942, was read and duly discussed and considered and the action taken by the Board of Directors at said meeting was, on motion duly made and seconded, unanimously ratified, confirmed and approved.

The minutes state that resolutions were unanimously adopted by the shareholders providing for the increase in the number of shares of stock which the parent was authorized to issue, and for preferences, qualifications, limitations, restrictions, and special or relative rights in respect of the shares of each class, and for the exchange of old shares of the parent for new shares, which resolutions were identical with the resolutions adopted by the board of directors on November 24, 1942. The minutes further state that a resolution was unanimously adopted ratifying, confirming, and approving the action of the board of directors of the parent on November 10, 1942, in conveying the Arizona ranch to Realty in full payment for 2,312 shares of the common stock of Realty.

During the period from December 7 to December 31, 1942, the parent's shareholders surrendered 746 shares of old A and 23,098 shares of old B common stock of the parent and received1951 U.S. Tax Ct. LEXIS 222">*247 235 shares of new preferred, 3,723 shares of new A common, 19,850 shares of new B common of the parent, 2,205 shares of Realty common stock, and $ 1,800 cash. As of December 31, 1942, five shares of old A and 39 shares of old B common stock of the parent were still outstanding. The 746 shares of old A and the 23,098 shares of old B common stock surrendered and received by the parent were cancelled.

During the period from December 7 to December 31, 1942, petitioner surrendered 180 shares of old A, and 21,771 shares of old B common stock of the parent and received 2,357 shares of new A and 19,593 shares of new B common stock of the parent: 2,177 shares of Realty common stock, and $ 50 cash. As of December 31, 1942, petitioner owned approximately 63 per cent of the new A and 98 per cent 16 T.C. 820">*831 of the new B common, or 92 per cent of the total common and preferred stock of the parent issued and outstanding, and approximately 94 per cent of the total Realty stock issued and outstanding.

The surplus account of the parent at the time of the exchange totaled $ 303,203.68, ³ computed as follows:

Prior to 1942 the subsidiary had never declared a dividend on its common stock, all of which was owned by the parent. Prior to 1942 the parent had never declared any dividends on its Class B shares, over 92 per cent of which was owned by petitioner. The only distribution by the parent to holders of Class B shares was the stock and cash distributed in exchange for old Class B shares. The parent had declared dividends on the Class A shares, less than 25 per cent of which was owned by petitioner, but such dividends prior to 1942 did not exceed a total of $ 2,512 in any one year.

The parent's distribution of 2,177 shares of Realty stock and $ 50 in cash to the petitioner in 1942 was equivalent to the distribution of a dividend taxable to the petitioner as ordinary income to the extent of the fair market value of the Realty stock and the sum of $ 45 representing the gain realized by the petitioner on the 1951 U.S. Tax Ct. LEXIS 222">*249 exchange of the odd share of old B common stock for $ 50 in cash.

Petitioner continued to hold the 2,177 shares of Realty common stock until 1946 when the assets of Realty were transferred to Western Development Co., a successor corporation. In connection with such transfer, petitioner received 2,177 shares of the 2,303 shares of the then issued and outstanding capital stock of Western Development Co. in exchange for his stock in Realty.

During the years 1942 to 1946, Realty owned and operated the ranch and maintained thereon 100 head of cows. This number was steadily decreased to about 50 during the last two or three years. One part-time cow-hand was employed thereon. Realty engaged in no other business activity. Petitioner spent about six months a year supervising the operation of the ranch.

Realty entered on its books of account and claimed on its Federal income tax returns the following operating losses:

16 T.C. 820">*832 Western Development Co. sold the ranch in 1947 for an amount in excess of $ 175,000. Petitioner continued to reside at the ranch a major part of his time until it was sold.

In1951 U.S. Tax Ct. LEXIS 222">*250 1949, the parent acquired a plant site in Chicago and began the construction of a building thereon. The total cost of this project was estimated at from $ 375,000 to $ 400,000.

Respondent on April 23, 1948, issued a notice of deficiency to the petitioner in which he made the following determination:

There has been included as taxable income to you under the provisions of Sections 22 (a), 115 (a), 115 (g), and 112 (c) of the Internal Revenue Code an amount of $ 138,611.05, representing a distribution to you by Lanteen Laboratories, Inc. of 2,177 shares of stock of the Lanteen Realty Co. and $ 50.00 cash. It is determined that at the date of distribution the 2,177 shares of stock of Lanteen Realty Co. had a fair market value of $ 63.65 per share or a total of $ 138,566.05, all of which constituted taxable income to you, and that the $ 50.00 cash constituted taxable income to you to the extent of $ 45.00.

The fair market value of the 2,177 shares of Realty stock received by petitioner between December 7, 1942, and December 31, 1942, was $ 50.22 per share or a total of $ 109,328.94. As a result of the transaction in issue, petitioner in 1942 received a dividend distribution from the1951 U.S. Tax Ct. LEXIS 222">*251 parent taxable as ordinary income in the total amount of $ 109,373.94.

OPINION.

Respondent has determined that the 2,177 shares of Realty stock and the $ 50 in cash received by the petitioner in 1942 in exchange for stock in the parent company represented a taxable distribution in the amount of $ 138,611.05 and that this sum constituted ordinary income to the petitioner in that year under the16 T.C. 820">*833 provisions of sections 22 (a), 115 (a)⁴1951 U.S. Tax Ct. LEXIS 222">*252 and 115 (g)⁵ or 112 (c) ⁶ of the Internal Revenue Code. Petitioner treated the exchange as tax free under sections 112 (b) (3)⁷ and 112 (g) (1) (D) ⁸ of the Internal Revenue Code and did not report his gain on the Realty stock and cash he received.

The over-all transaction here in issue was planned and executed in the following manner: On November 9, 1942, the subsidiary declared a dividend to the parent by the conveyance of the Arizona ranch. The parent on November 19, 1942, transferred1951 U.S. Tax Ct. LEXIS 222">*254 the ranch to Realty in exchange for 2,312 shares of its capital stock. During the period from December 7 to December 31, 1942, the parent company undertook a recapitalization whereby it distributed to its shareholders 2,205 shares of the Realty stock, $ 1,800 in cash and its own new capital stock in exchange for the old stock of the parent.

Petitioner selects from this series of transactions the two exchanges between the parent and Realty and between the parent and its stockholders and characterizes them as integral parts of a single "plan of reorganization" within the literal requirements of section 112 (b) (3). Petitioner explains that the requirement that there be a "reorganization" is complied with by the transfer of the ranch to Realty in exchange for all of its stock. See sections 112 (g) (1) (D) and 112 (h). ⁹ Therefore, petitioner reasons that parent and Realty were parties in a section 112 (g) (1) (D) reorganization and were parties to a reorganization 16 T.C. 820">*834 within the meaning of section 112 (g) (2). ¹⁰ Petitioner contends that the exchange between the parent and its stockholders was in pursuance of the exchange between parent and Realty and since the latter exchange1951 U.S. Tax Ct. LEXIS 222">*255 was a reorganization within the definition of section 112 (g) (1) (D), then the former exchange was in pursuance of a "plan of reorganization" as required by section 112 (b) (3). Petitioner further argues that the requirement that there be an exchange of stock for stock was met by the parent's distribution of Realty stock and its own new capital stock to its stockholders in exchange for its old capital stock.

1951 U.S. Tax Ct. LEXIS 222">*256 We agree that the exchange between the parent and its shareholders met the literal requirements of section 112 (b) (3) of the Internal Revenue Code. See Hortense A. Menefee, 46 B. T. A. 865; Lewis v. Commissioner, 176 F.2d 646, affirming 10 T.C. 1080; Estate of Elise W. Hill, 10 T.C. 1090; W. N. Fry, 5 T.C. 1058.

However, in order that petitioner's gain be postponed he must show not only that the exchange literally complied with section 112 (b) (3) but that the new arrangement intrinsically partook of those characteristics and elements of reorganization which underlie the Congressional exemption, and that it was not "merely a vehicle, however elaborate or elegant, for conveying earnings from accumulations to the stockholders." Bazley v. Commissioner, 331 U.S. 737">331 U.S. 737. The Supreme Court, in 331 U.S. 737">Bazley v. Commissioner, supra, specifically stated that:

In the case of a corporation which has undistributed earnings, the creation of new corporate obligations which are1951 U.S. Tax Ct. LEXIS 222">*257 transferred to stockholders in relation to their former holdings, so as to produce, for all practical purposes, the same result as a distribution of cash earnings of equivalent value, cannot obtain tax immunity because cast in the form of a recapitalization- reorganization. The governing legal rule can hardly be stated more narrowly. To attempt to do so would only challenge astuteness in evading it.

Petitioner would have us approach the "reorganization" in issue as a transaction which started with the ranch in the hands of the parent as a dividend received from the subsidiary. However, to ignore the plain fact that the "reorganization" represented only the latter phase of a larger over-all plan, which plan had been thoroughly discussed and finally decided upon long prior to the purported "reorganization" and was actually launched by the severance of the ranch from the subsidiary, would be completely unrealistic and serve only to distort the genuine substance of the whole transaction.

The transaction with which we are here concerned stemmed from 16 T.C. 820">*835 the subsidiary company's decision in 1942 to abandon the hormone development program which it had conducted at the Arizona ranch. 1951 U.S. Tax Ct. LEXIS 222">*258 At that time, the subsidiary had just settled its differences with the Commissioner concerning its operating expenses for ranch operations and its liability for the surtax under section 102 for the years 1939 and 1940 and there was doubt as to what the Commissioner's attitude would be in respect to these same matters for the years 1941 and 1942. The subsidiary's difficulties with the Commissioner arose to a large degree from the devotion of the ranch and its highly personalized improvements to the use and enjoyment of the petitioner. The ranch represented a substantial part of the subsidiary's accumulated earnings and profits and, serving no further function in the business of the subsidiary after the abandonment of the hormone project, was available for distribution as a dividend. Therefore, it was feared that the Commissioner would also impose the surtax under section 102 with respect to the subsidiary's accumulated earnings and profits for the years 1941 and 1942 should the subsidiary retain the ranch.

The parent company, as the sole stockholder of the subsidiary, was certain to receive the ranch if it was decided to distribute it as a dividend, and the receipt of the ranch1951 U.S. Tax Ct. LEXIS 222">*259 by the parent would place it in an equally hazardous position with respect to section 102 for it would then immediately swell the accumulated earnings and profits of the parent which were already in excess of $ 145,000 as of the end of 1941. As the ranch served no useful function in the business of the parent company, there was no good reason for the parent's retaining it and, therefore, it would be available for distribution as a dividend by the parent. If the parent were simply to declare a dividend consisting of the ranch to its stockholders, including the petitioner, the distribution certainly would be taxable to the stockholders as ordinary income. If the parent were to convey the ranch to its stockholders in exchange for stock in the parent, the best tax result it could hope for would be its treatment as a distribution in partial liquidation under section 115 (c)¹¹ taxable at capital gains rates, but it still would run a very serious risk of having the distribution taxed as an ordinary dividend under section 115 (g). See Flanagan v. Helvering, 116 F.2d 937; Smith v. United States, 121 F.2d 692; 331 U.S. 737">Bazley v. Commissioner, supra.1951 U.S. Tax Ct. LEXIS 222">*260 The same alternatives and risks were open to the parent company for the distribution of the Realty stock once it had transferred the ranch to Realty in exchange for its stock.

16 T.C. 820">*836 Petitioner, who apparently was well aware of the situation, proposed that the ranch be transferred by the subsidiary to a newly organized corporation in exchange for its capital stock which would then be transferred by the subsidiary to the petitioner "on an approximate equal valuation basis" in exchange for Class B common1951 U.S. Tax Ct. LEXIS 222">*261 stock in the parent. Filson, the accountant for the subsidiary and parent companies, informed the petitioner that he would incur a tax under that procedure. Filson discussed all of the tax aspects involved and finally suggested an alternative plan whereby the ranch would be distributed as a dividend by the subsidiary to the parent, after which the parent company would organize Realty, transfer the ranch to Realty in exchange for its stock, and thereafter undergo a recapitalization in which it would distribute the Realty stock along with new stock of the parent to its stockholders in exchange for its old capital stock. Extended correspondence was exchanged between the petitioner and Filson, all of it pertaining to the tax consequences of the proposed disposition of the ranch, and the plan proposed by Filson was ultimately adopted.

It is clear from the correspondence between the petitioner and his advisers that the plan was designed and executed so as to accomplish for all practical purposes a distribution of accumulated earnings and profits, and that the sole purpose of the "reorganization" of the parent was to avoid the incidence of any tax on the distribution of the ranch.

Petitioner1951 U.S. Tax Ct. LEXIS 222">*262 attempts to refute this conclusion by arguing that a reorganization and recapitalization of the parent were deemed necessary for the future development of additional products and that Realty was organized to acquire a building site for a new factory after the war. However, no expression of business purpose was made until after the final plan for the whole transaction had been drafted and decided upon by the petitioner, Filson, and Eckert, and the correspondence between these persons in formulating the plan leaves no doubt that they were solely concerned with the prospects of a tax-free distribution rather than "business purposes."

A close examination shows beyond all reasonable doubt that the "net effect" of the plan of reorganization was for all practical purposes equivalent to the distribution of a dividend consisting of the ranch and cash to the stockholders of the parent company, particularly the petitioner, and demonstrates the absence of the "business purposes" suggested by the petitioner.

One would think if the parent company genuinely intended to use Realty in the acquisition of a building site and the construction of a new plant, it would have retained control of Realty. 1951 U.S. Tax Ct. LEXIS 222">*263 However, from the outset the plan contemplated a distribution of the Realty stock to the stockholders of the parent and the distribution was carried out, leaving the parent with less than 5 per cent of the outstanding stock of Realty. It is also interesting to note that it was the parent company 16 T.C. 820">*837 which in 1949 acquired the plant site and began the construction of a new building.

Nor is the petitioner's explanation that the change in the parent's capital structure was made in anticipation of a need for additional funds with which to promote the manufacture and sale of new products consonant with the fact that none of its authorized preferred stock, only a small part of its Class A stock, and less than one-half of its Class B stock had been subscribed for at that time, or the fact that at the close of 1941 it had accumulated earnings of $ 145,064.17 and in 1942 realized earnings of $ 10,980.13 apart from the value of the ranch received in that year from the subsidiary. Its dividends in years prior to the "reorganization" never exceeded $ 2,600. It is difficult under these circumstances to believe that the parent honestly anticipated a need for bringing outside capital into1951 U.S. Tax Ct. LEXIS 222">*264 the business.

For that matter, the so-called recapitalization does not appear to us to have resulted in any improvement of the parent's position in raising new capital. The only change made in its capital stock was the authorization of an additional 800 shares of preferred stock at a par value of $ 50 per share and no change was made in the number of Class A or Class B shares the parent was authorized to issue.

As a result of the so-called recapitalization, substantially all of the stock of Realty was routed directly into the hands of the petitioner. This was accomplished by the exchange of one share of Realty stock, one share of new A stock, and nine shares of new B stock for every block of ten shares of old B stock. As it was provided that shareholders would receive $ 50 in cash for odd shares of old B stock, those stockholders with less than ten shares of old B stock were completely excluded from acquiring any interest in Realty and as the petitioner owned 21,771, or 94 per cent, of the 23,137 shares of old B outstanding, he was assured of almost complete ownership of Realty and thereby the continued use and enjoyment of the ranch.

Finally, the parent company's distribution 1951 U.S. Tax Ct. LEXIS 222">*265 of Realty stock and cash to its shareholders represented a distribution of almost one-half of the accumulated earnings and profits of the parent company.

All of the facts and circumstances attendant to the transaction in issue support the respondent's determination that the net effect of the distribution of the Realty stock and the $ 50 in cash to the petitioner was the same as the distribution of a dividend taxable as ordinary income to the extent of the fair market value of the Realty stock and the $ 45 realized on the exchange of the odd share of old B for $ 50 in cash. In 1942, both the subsidiary and the parent companies were faced with tax difficulties under section 102 arising from their excessive accumulations of undistributed earnings and profits. The subsidiary company had never paid a dividend on its common stock prior to 1942. The parent company had never declared a dividend on its 16 T.C. 820">*838 Class B common stock, over 92 per cent of which was owned by the petitioner, and dividends on its Class A common stock never exceeded $ 2,600 in any year prior to 1942. All of the facts, and particularly the correspondence between the petitioner and Filson, demonstrate that the 1951 U.S. Tax Ct. LEXIS 222">*266 entire transaction involving the severance of the ranch from the other assets of the subsidiary, the organization of Realty, and the distribution of the Realty stock and cash to the petitioner and the other stockholders of the parent company in exchange for stock in the parent was dominated by a desire of the subsidiary and parent companies to rid themselves of the ranch in order to avoid the imposition of section 102 and at the same time to place the ranch in the hands of the petitioner by some means other than the direct declaration of a taxable dividend.

An analysis of the end results of the completed transaction further demonstrates to our satisfaction that the net effect of the purported "reorganization" was for all practical purposes the same as a distribution of a substantial part of the accumulated earnings and profits of the parent which were at that time available for distribution to the stockholders as ordinary dividends. The record clearly shows that the plan of "reorganization" could not and did not have the effects other than tax avoidance which the petitioner attempts to attribute to it. Although the parties saw fit to cast the transaction in the literal form of a 1951 U.S. Tax Ct. LEXIS 222">*267 reorganization under sections 112 (b) (3) and 112 (g) (1) (D), it was not, in our judgment, "the kind of transaction with which section 112 (g) 'in its purposes and particulars, concerns itself.'" Estate of John B. Lewis, 10 T.C. 1080, affd., 176 F.2d 646. See also Flanagan v. Helvering, supra;Smith v. United States, supra;331 U.S. 737">Bazley v. Commissioner, supra;James F. Boyle, 14 T.C. 1382, affd., C. A. 3 (Feb. 27, 1951).

We are, therefore, of the opinion that the Commissioner was correct in determining that the petitioner's income for 1942 should be increased under the provisions of sections 22 (a), 115 (a) and 115 (g) of the Internal Revenue Code by the fair market value of the 2,177 shares of Realty stock and the sum of $ 45 representing the gain from the $ 50 in cash received incident to the exchange.

Respondent has taken the position that the 2,177 shares of Realty stock and the cash received by the petitioner in the exchange represented a taxable distribution in the amount of $ 138,611.05. The sole 1951 U.S. Tax Ct. LEXIS 222">*268 remaining issue relates to the fair market value of the 2,177 shares of Realty stock as of December 1942, when they were distributed to the petitioner, which in turn depends upon the fair market value of the ranch at that time.

The parties are agreed that the fair market value of the "miscellaneous ranch property" was equal to its undepreciated cost as of 16 T.C. 820">*839 November 1942, or the sum of $ 26,109.53. Petitioner contends that the fair market value of the remaining properties which we have previously identified herein as the "main dwelling unit" and the "cattle ranch unit" was not in excess of $ 42,500. Respondent has determined the value of these properties as $ 121,049.85.

Certain facts material to the question of value are undisputed. The undepreciated cost of the properties in issue as of November 1942 was $ 121,049.85 which was reflected in the value of $ 147,159.38 assigned to the ranch by the parent in reporting the receipt of the ranch as a dividend on its 1942 income tax return. The latter amount was subsequently increased by the Commissioner to $ 153,000, on the basis of which valuation the parent paid an additional tax and thereafter challenged the Commissioner's1951 U.S. Tax Ct. LEXIS 222">*269 determination by claims for refund. The ranch was sold in 1947 for an amount in excess of $ 175,000.

We have also been accorded the benefit of the reports and opinions of six qualified witnesses each of whom independently inspected and appraised the properties in question. The testimony of these experts in our judgment represents a complete analysis of all the factors and conditions material to the fair market value of the ranch. The possibilities of a purchaser using the ranch as a cattle outfit, a "dude ranch", a dairy farm, a boys' camp, as the hobby and residence of a person of substantial wealth and for breeding purebred cattle were thoroughly discussed and opinions were offered as to the value of the ranch to such a purchaser for any one or a combination of such uses.

The prices at which other Arizona properties changed hands, the physical characteristics of such properties, their relative advantages and disadvantages, the circumstances surrounding the sales, and the experiences of the purchasers in putting the properties to various uses were described and discussed. Opinions were expressed as to the relation of the sales price of such properties to the original costs and1951 U.S. Tax Ct. LEXIS 222">*270 the reproduction costs in 1942, the effect of various conditions arising from the war, and the probable reaction of purchasers to the luxury items and other unusual features of the ranch which had been installed primarily for the petitioner's personal convenience and enjoyment.

Unfortunately, the greater part of this testimony is highly argumentative, resulting in conclusions as to fair market value which are for all practical purposes completely irreconcilable. The petitioner's three expert witnesses placed the combined value of the "main dwelling unit" and the "cattle ranch unit" at $ 42,000, $ 50,000 and $ 50,000, respectively, whereas the respondent's three experts fixed values of $ 114,000, $ 121,164 and $ 127,000, respectively, for the same properties. Whereas one expert for the respondent placed the 16 T.C. 820">*840 value of the ranch at $ 60,000 for use as a cattle outfit, one of the petitioner's witnesses stated that in his opinion it had practically no value at all for this purpose. Nor were the experts able to produce what we can fairly regard as an example of the sale of a comparable property.

The sharp disagreement between the experts in respect to every element of value 1951 U.S. Tax Ct. LEXIS 222">*271 is merely reflective of the inherent difficulty in fixing a fair market value for properties of the unusual character and restricted use and appeal of the ranch in question, and it is not surprising to find that the record points to no specific figure as the only correct fair market value of the ranch as of December 1942.

We have carefully studied all of the known facts. We have considered and weighed all of the observations, arguments and opinions of the expert witnesses, the evidence of other sales of Arizona ranch properties at or about the time in question, the possible uses for the ranch, the original cost, the probable reproduction cost, the effect of war conditions and all of the other evidence material to the question of value. Our best judgment on the basis of all this evidence is that the fair market value of the "main dwelling unit" and the "cattle ranch unit" as of December 1942 was $ 90,000. The parties having stipulated that the fair market value of the "Miscellaneous ranch property" was $ 26,109.53, it follows that the total fair market value of the Arizona ranch in December 1942, was $ 116,109.53. As Realty issued a total of 2,312 shares of stock in exchange for1951 U.S. Tax Ct. LEXIS 222">*272 the ranch the Realty shares possessed a fair market value of $ 50.22 per share, and the 2,177 shares received by petitioner incident to the exchange in issue had a fair market value of $ 109,328.94.

Therefore, the petitioner, as a result of the exchange in controversy, received a taxable distribution of dividends from the parent company in 1942 in the total amount of $ 109,373.94.

Decision will be entered under Rule 50.